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Understanding the Tax Cuts and Jobs Act

When it comes to the Tax Cuts and Jobs Act of 2017—which went into effect on January 1, 2018—“it’s important to talk to a good tax advisor about what is and isn’t in the law,” says Hayden Adams, CPA and director of tax and financial planning at the Schwab Center for Financial Research. “It was passed so quickly that there’s a lot of incorrect or incomplete information circulating.”

According to Hayden and other estate- and tax-planning experts at Schwab, there are nine key areas to which taxpayers should pay particular attention.

No. 1: Standard deductions

The tax law increased the standard deduction from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for married couples filing jointly. As a result:

Those who typically take the standard deduction should see a decrease in their tax bill for 2018.

Those whose itemized deductions are normally less than the new standard deduction should also see a smaller tax bill this year.

Those whose itemized deductions exceed the new standard deduction are still free to itemize—though far fewer are expected to do so going forward, Hayden says.

No. 2: Income-tax rates and brackets

Those married and filing jointly will likely see their 2018 tax bills decrease for two reasons:

Tax rates were lowered for five of the seven income brackets.

Tax brackets have also shifted—meaning in many cases more income will be taxed at a lower rate.

For example, if you’re married and filing jointly, your first $19,050 in taxable income is still taxed at 10%; however, your next $58,349 is taxed at 12% rather than 15%. And not only is the next bracket 22% rather than 25%, but the bracket itself has expanded to include your next $87,599 in income rather than your next $78,749.

Some single filers, in contrast, didn’t fare nearly so well (see “Singled out,” below).

Singled out

Married couples filing jointly should see their tax bill decline, while higher-earning single filers may well pay more.

No. 3: Child tax credit

Not only has the new law doubled the child tax credit—to $2,000 per child—but also more taxpayers will qualify for it, because the level of income at which the benefit phases out has been increased from $75,000 to $200,000 for single filers and from $110,000 to $400,000 for married couples filing jointly. (See “What’s the difference between a credit and a deduction, anyway?” below.)

No. 4: Alternative minimum tax (AMT)

The AMT was originally intended to prevent high-income earners from taking unfair advantage of tax deductions and loopholes. In practice, it requires taxpayers to calculate their tax liabilities twice—once under the regular tax rules and again under the AMT rules—and pay the higher of the two.

In order to shield lower- and middle-income earners from being unfairly affected by the AMT, the IRS allows a set amount of income to be exempted from AMT calculations. In 2017, the exemption was $54,300 for single filers and $84,500 for married couples filing jointly. Under the new law, those figures have been increased to $70,300 and $109,400, respectively.

What’s more, the income limits at which the above exemptions phase out were dramatically increased in 2018—to $500,000 for single filers (from $120,700 in 2017) and $1 million for married couples filing jointly (from $160,900 in 2017). As a result, far fewer taxpayers are expected to be subject to the AMT going forward.

And, unlike the regular tax system, the AMT has only two tax rates: 26% and 28%. In 2018, the 26% rate applies to the first $95,750 in income for single filers (compared with $93,900 in 2017) and the first $191,500 in income for married couples filing jointly (compared with $187,800 in 2017). The 28% rate applies to any income above those amounts.

No. 5: 529 college savings plans

So-called college savings plans aren’t just for college anymore. That’s because under the new law parents can withdraw up to $10,000 per student per year from a 529 to pay for primary or secondary education—with two caveats: The funds must be used for tuition only, and not all states permit such 529 plan spending, so be sure to check your state’s rules before withdrawing any funds.

“Even if you can use 529 funds for K–12 tuition, that doesn’t mean you should,” Hayden cautions. “One advantage of 529s is their long-term potential for tax-free gains—to say nothing of saving for college itself—and both can be compromised if you begin drawing down the funds early.”

No. 6: Roth IRAs

The new tax law didn’t affect tax-deferred retirement accounts directly, but it may have increased the appeal of converting holdings in your tax-deferred IRA to a Roth IRA, whose withdrawals are entirely tax-free* and are exempt from the required minimum distributions mandated by the IRS beginning at age 70½.

“Individual income-tax rates might never be this low again in our lifetimes,” says Bob Barth, a Schwab wealth strategist. “If you’re thinking about converting, it might make more sense to do so in the next few years, while tax rates are still relatively low.”

*Provided the account holder is over age 59½ and has held the account for five years or more.

No. 7: Charitable giving

Charitable donations are still deductible, so long as you itemize your deductions, which far fewer taxpayers are expected to do now that the standard deduction has increased (see No. 1). Be that as it may, there remain ways to preserve the benefit if you’re strategic about your giving.

One approach is to concentrate your giving into a single year, particularly if you’re near the threshold for itemized deductions. Kim Laughton, president of Schwab Charitable, notes that a donor-advised fund (DAF) is particularly well-suited to this purpose. “DAFs allow the account holder to donate a lump sum in the current year—and potentially include the gift among her or his itemized deductions—while parceling out the money to qualified charities over time,” she says.

No. 8: Estate taxes

Like the standard deduction, the estate-tax exemption was also doubled under the new law—to $11.18 million for single filers and $22.36 million for married couples.

“Most people assume they won’t be hit with estate taxes, given the new higher limits,” says Marianne Hayes, a CPA and wealth strategist with Schwab Private Client. “The increase is scheduled to expire after 2025, however, so I encourage wealthier clients to anticipate what their estate plans might look like should the exemption come back down.”

Certain types of trusts can provide flexibility in the event of future exemption reductions. A Disclaimer Trust, for example, allows a surviving spouse to renounce ownership of all or a portion of the decedent’s estate, which is then transferred to the trust, without being taxed. However, Marianne cautions clients to discuss the ins and outs of any such strategy with an attorney and/or a tax advisor before making a final decision.

No. 9: Deductions

And now for the bad news: Some taxpayers who itemize could end up paying more in taxes due to new deduction limitations. For example, the new law:

Limits the deduction for state and local taxes—including property taxes—to $10,000. Taxpayers in high-tax states in particular may feel the sting (we’re looking at you, California, New Jersey and New York).

Allows you to deduct the interest only on the first $750,000 of your mortgage debt. (For primary homes purchased before December 15, 2017, you can continue to deduct interest on up to $1 million of mortgage debt.)

Eliminates the mortgage-interest deduction on home-equity loans, unless they are used to buy, build or substantially improve the home that secures the loan.

As with most financial considerations, a little bit of foresight can yield substantial savings.

“Don’t wait until the year is over before discussing your tax situation with a professional,” Hayden says. “You want to be doing everything you can do now to maximize your deductions well ahead of filing season.”

What’s the difference between a credit and a deduction, anyway?

A tax deduction indirectly reduces the amount of taxes owed by lowering your taxable income—and so is worth the same percentage as your effective tax rate. For example, if you claim a $100 deduction and your effective tax rate is 28%, you would shave $28 off your bill.

A tax credit, on the other hand, provides a dollar-for-dollar reduction of your income-tax liability. For example, a couple that owes $10,000 in taxes and has one child would see that liability cut to $8,000 after applying the newly doubled child tax credit of $2,000 (see No. 3). “It would take $7,143 in itemized deductions to realize the same level of reduction,” Hayden says, assuming the same effective tax rate as the example above.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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